Investment Vehicle

8/3/2019 Investment Vehicle

1/2970

Introducon

In India, the concept of saving is well understood by most people, however

very few understand the concept of invesng. We all save money to cater

for our future needs. In order to get best out of our saved money, we mustunderstand:

Our possible future requirements, needs and aspiraons.

Various avenues/vehicles available for invesng this saved money.

Pros and cons of these investment vehicles.

What are various concerns and how to address these concerns?

Once we understand the available investment opportunies along with the

pros and cons of invesng in these vehicles, it would become easier to align

our investments to achieve our nancial Goal.

Unit 4: Investment Vehicles


2/2971

Learning Goals

Investment Vehicles

4.1 Investment Concerns Returns, Capital Protecon, Inaon, Taxaon,

Liquidity, Divisibility4.2 Small Savings Schemes Public Provident Fund, Naonal Savings Cer-

cate, Kisan Vikas Patra, Senior Cizen Savings Scheme, Post Oce

MIS. PO T&D

4.3 Fixed Income Instruments Government Securies (Bonds, T-Bills, CD,

CP, Zero Coupon Bonds, Promissory Note, etc.), Corporate Securies

(Corporate Bonds, etc.) Corporate Deposits, Bank Deposits, etc. Small

Savings Instruments such as Public Provident Fund, Naonal Saving

Cercate, Kisan Vikas Patra, Post Oce Monthly Income Scheme, Post

oce Term Deposit, Post Oce Saving Accounts, Senior Cizen SavingScheme, etc.

4.4 Mutual Fund Products - Generic (Equity Growth Funds, Income Funds,

Balanced Funds, Liquid Funds, Index Funds, ETFs, FMPs,), Specic (,

Themac & Sectoral Funds, , Arbitrage Funds, etc.), Overseas oppor-

tunies, Short-term Funds for parking liquidity, diversied equity fund.

4.5 Equies Types of Shares, Dividend Yield, EPS, P/E, etc., Modes of Valu-

aon, Porolio Management aspects, Value Growth invesng.

4.6 Derivaves and Commodies Essenal features, Types-Future and

Opons.

4.7 Real estate - Forms of real estate investment, nancing real estate,

Costs of buying and maintaining, Loans and nancing.

4.1 Investment Concerns

The most common concerns that needs to be addressed, while invesng

and choosing the assets are-

1. Returns

The return from the investment could be in the form of capital gains, cash

ows, or both. A rered person may be more interested in regular cash

ows to cater for his day to day needs, where as a younger person in ac-

cumulaon phase may be more concerned with growth of his investment

for creang a corpus for his rerement.


3/2972

2. Capital Protecon

Protecng your capital is the most important aspect of investment. By na-

ture majority of us in India are risk averse. We feel investments are risky and

thus leave most of our saved money in instruments earning low income,

without understanding the eect of inaon, which reduces the value of

our money every day. Risk is part of our lives. Anything and everything wedo have some kind of risk associated with it. Even if we cross a road, there

is risk of meeng with an accident. Risk and reward go hand in hand, higher

the risk, more is the reward expected. Each of the investment assets has its

own associated risk and reward/return, which one must understand before

invesng his money in any of the investment vehicles.

3. Inaon

By denion, inaon is the rise in general level of prices of goods and ser-

vices in an economy over a period of me. When prices rise, each unit of

currency buys fewer goods and services, resulng in erosion in the purchas-

ing power of money. This is a loss in the real value of money. The aim of in-

vestment is to get returns in order to increase the real value of the money.

In other words our investment asset should be able to beat inaon.

4. Taxaon

Income from our investment assets is liable to taxaon, which is going to

reduce our returns. The real return from any investment vehicle would be

the return aer taxaon and inaon.

5. Liquidity

It is the ability to convert an investment into cash quickly, without the loss

of a signicant amount of the value of the investment. Any amount which

may be required at a short noce should only be invested in an investment

vehicle with high liquidity.

6. Divisibility

This is the ability to convert part of the investment asset into cash, without

liquidang whole of the asset. Divisibility may be an important considera-

on for many investors, while choosing an investment vehicle. For example,

while invesng Rs. 15 lacs in senior cizen scheme, one could increase thedivisibility without aecng returns by dividing this investment in cket size

of Rs. 2-3 lacs, rather than invesng Rs.15 lacs in one go.


4/2973

Before comming your capital to any investment vehicle, it is preferable

to consider your nancial needs, goals, and aspiraons, as well as the risk

prole.

Avenues for Saved Money / Investment Vehicles

Various places where one can park his saved money can be broadly classi-ed into:

1. Financial Assets

2. Non-Financial Assets

Financial Assets

Financial Assets can further be classied into:

1. Cash instruments

2. Debt instruments

3. Equity instruments

Cash Instruments

Money in cash form is most useful in emergencies because of easy access;

however it tends to lose its value because of inaon. Over a period of

me purchasing power of cash money would considerably reduce. Someof the future requirements cannot be ancipated like sudden health prob-

lem, accidents, natural calamies etc. These emergencies require sudden

unexpected cash out ow, for which we must prepare ourselves. Thus it is

very essenal to have some of our saved money in cash form to cater for

these emergencies. Now queson arises, how much money should be kept

in cash form, and what are various cash instruments available. On an aver-

age three to six months of our average monthly expenses should be kept in

cash instruments.

Various cash instruments could be:

i) Cash in Hand

ii) Cash in Bank

Debt Instruments

Invesng in debt instruments is like lending your money to a third party,

who ulizes this money to earn more money. Generally, periodically part ofthis money is passed on to you as interest. The capital is returned aer the

spulated me period. These instruments beat inaon to some extent;


5/2974

however taxaon may be a concern in many of these instruments. The lock

in period could be short, medium or long term depending on the type of

debt instrument chosen. Capital is relavely safe; returns are lower than

equity but higher than cash instruments.

Various debt instruments used are:

1. Small Saving Schemes2. Government and Corporate Debt Securies

3. Bank deposits

4.2 Small Saving Schemes

Various schemes which fall under this category are:

1. Public Provident Fund

2. Naonal Savings Cercates3. Post oce Monthly Income Scheme

4. Senior Cizen Saving Scheme

5. Post Oce term deposit

6. Post oce savings Accounts

7. Post oce recurring deposit

8. Kisan Vikas Patra

Public Provident Fund (PPF)

Public Provident Fund Scheme, 1968 came into force w.e.f. 01 July 1968

following Government of India, MOF (DEA) nocaon GSR 1136 dated

15/06/1968 and further amended from me to me.

Account can be opened by an individual for himself/herself, and or on

behalf of a minor of whom he/she is a guardian. Opening of account on

behalf of HUF (Hindu undivided family), AOP (Associaon of persons),

and BOI (Body of individuals) has been disconnued w.e.f. 13-05-2005;vide RBI nocaon GSR291 (E). Non Resident Indians are not eligible

to open an account under the Public Provident Fund Scheme:-Provided

that if a resident who subsequently becomes Non Resident Indian dur-

ing the currency of the maturity period prescribed under Public Provi-

dent Fund Scheme, may connue to subscribe to the Fund ll its matu-

rity on a Non Repatriaon Basis. [MOF (DEA) Nocaon No GSR 585

(E) dated 25.7.2003]

Joint account cannot be opened, however nominaon facility is avail-

able. The PPF account can be opened in branches of State Bank of India, a few

branches of some naonalized banks, and all head post Oces.


6/2975

Account matures aer expiry of 15 years from the end of nancial year

in which the account was opened. For example if the account is opened

in the nancial year 2000-2001, the account shall mature on 01 Apr

2016. In other words this is an instrument with a term of 16 years.

Minimum amount that needs to be deposited in this account is Rs.500/-

and maximum amount that can be deposited in a nancial year in thisaccount is Rs.70,000/-. Subscripon should be in mulples of Rs.5/- and

can be paid in one lump sum or in installments not exceeding 12 in a

nancial year.

Contribuon to PPF is eligible for deducon under sec 80C of Income

tax Act 1961. The Interest earned is completely exempt from tax with-

out any limit as per the present tax laws.

Interest at the rate, noed by the Central Government in ocial ga-zee from me to me, shall be allowed for calendar month on the

lowest balance at credit of an account between the close of the h

day and the end of the month and shall be credited to the account at

the end of each year. At present, the interest rate is 8% p.a.

Loans: There is a loan facility available. An investor can borrow any me

aer compleon of 5 years. The amount of loan cannot exceed 25% of

the balance in account at the end of second year immediately preced-

ing the year in which the loan is applied for.

Repayment of loan and interest: - (1) The principal amount of a loan

under this Scheme shall be repaid within thirty six months from sanc-

on. The repayment may be made either in one lump sum or in two

or more monthly installments. The repayment will be credited to the

subscribers account. (2) Aer the principal of the loan is fully repaid,

the subscriber shall pay interest thereon in not more than two month-

ly installments. The interest shall be charged at the rate of 1% p.a. ofthe principal for the period of the loan. If the loan is repaid only in

part within the prescribed period of thirty six months, interest on the

amount of loan outstanding shall be charged at 6% p.a. instead of at 1%

p.a.

It is recommended to avoid loans since interest is paid out of non tax-

able interest and therefore the advantage gets diluted.

Paral Withdrawals are allowed beginning from 7th year and everyyear thereaer. An account holder can withdraw 50% of his balance at

the end of the 4th or the 1st previous nancial year, whichever is lower.


7/2976

For example, if the account is opened in Financial Year 2000-2001. You

may add 6 years to the nancial year end i.e. 2001+6=2007 (FY 2006-

2007). Accordingly, the 4th preceding year will be 2007-4= 2003 (FY

2002-2003) and preceding year will be 2007-1= 2006 (FY2005-2006).

So the amount of 1st withdrawal in the 7th year, FY 2006-2007 is 50% of

the balance to the credit as on 31-03-2003 or 30-03-2006, whichever is

lower.

The account can be connued for a block of 5 years aer maturity. This

facility is available for any number of blocks aer expiry of extended

period. The connuaon can be with or without contribuon. Once an

account is connued without contribuon for more than a year, the op-

on cannot be changed.

In post maturity connuaon with fresh subscripons, one can with-

draw up to 60% of balance at the commencement of each extendedperiod in one or more installments, but only once per year.

In post maturity connuaon without fresh subscripons, any amount

in part or full, can be withdrawn in installments but not exceeding once

in a year.

A PPF account is not subject to aachment (seizure of the account by

Court order) under any order or decree of a court. However income tax

authories can aach PPF accounts to recover tax dues.

A person can have only one account in his name. Two accounts even at

dierent places anywhere in India are not permied.

Naonal Saving Cercates

NSC-VIII has a six years term with tax benets under secon 80-C of Income

Tax Act, 1961. Minimum investment is Rs.500/- without any maximum lim-it. It can be bought by an individual or jointly by two adults. Nominaon

even with joint holders is possible. NRI, HUF, Companies, trusts, sociees,

or any other instuons are not allowed to purchase the Naonal Saving

Cercates.

Interest on this cumulave scheme is 8% p.a. compounded half yearly,

which works out to be 8.16% p.a.

Premature encashment is allowed only in case of death of the holder,

forfeiture by a pledgee, or under orders of court of Law. Cercates are available in denominaons of Rs. 100, 500, 1000, 5000,

and 10000.


8/2977

Kisan Vikas Patra

In this scheme minimum investment is Rs.100/-, without any maximum

limit.

Investment doubles in 8 years and 7 months, which works out to rate of

return of 8.41% p.a. compounded annually.

No Tax deducon at source and a withdrawal facility aer two and ahalf years is available.

It can be pledged as a collateral security for raising money.

Senior Cizen Savings Scheme

Eligibility is 60 years of age or above, on the date of opening the account.

Proof of age and a photograph of account holder are required. The age limit

is reduced to 55 years in case of an individual rering on superannuaon

or otherwise, or under VRS or special VRS, provided the account is opened

within one month of date of receipt of rerement benets. The rered per-

sonnel of Defence Services, excluding Civilian Defence Employees, shall be

eligible irrespecve of age limit.

NRIs, PIOs and HUF are not eligible to invest in this scheme.

Maximum limit is Rs.15,00,000/-(Rupees een Lac only), however in

case of rerees before the age of 60 years the limit is restricted to re-rement benets or Rs15 Lac whichever is less. Any Post Oce in India

doing savings bank work, or an oce or banking company or instu-

on authorized by Central Government can operate this scheme. An

investor can open more than one account subject to the condion, that

amount in all accounts taken together does not at any point of me

exceed Rs.15 Lac.

At the same accounts oce, two or more accounts cannot be opened

during one month. Some oces insist on a gap of 30 days.

The investment is non transferable and non tradable.

The interest rate is 9% p.a. payable quarterly. Annualized equivalent is

9.31% p.a. assuming the interest component is re-invested. The benet

of secon 80C is available on investment but interest is fully taxable.

The term for the scheme is 5 years. A oneme extension of three years

is allowed, if applied within one year of its maturity.


9/2978

Premature closure is allowed aer expiry of one year subject to follow-

ing condions-

- Aer expiry of one year but before 2 years, 1.50 % of deposit shall be

deducted.

- Aer expiry of 2 years, 1% of the deposit shall be deducted.

- No deducon is made in case of closure of account due to the death

of the account holder.

Nominaon facility is available even in case of joint account.

Post Oce Monthly Income Scheme (POMIS)

This scheme provides a regular monthly income to the depositors and

has a term of 6 years.

Minimum amount of investment is Rs.1500/-, and maximum amount

in case of single account is Rs.4,50,000/-, and in case of joint account is

Rs.9,00,000/-.

Interest rate is 8% p.a. payable monthly with a bonus of 5% payable on

maturity.

Nominaon facility is available.

Premature withdrawal / encashment / closure and Penalty

Premature withdrawal of the invested amount is allowed aer 1 year ofopening the account.

If the account is closed between 1 and 3 years of opening, 2% of the

deposited amount is deducted as penalty. If it is closed aer 3 years of

opening, 1% of the deposited amount is charged as penalty.

The bonus amount is forfeited when you close the account early.

Post Oce Time Deposits (POTD)

These are similar to xed deposits of commercial Banks. Interest rates are

calculated half yearly and withdrawals are permied aer six months. No

Interest is paid on closure of accounts before one year, and thereaer the

amount of deposit shall be repaid with interest @2% below the corre-

sponding Time Deposit rate for the completed number of years. Accounts

can be pledged as a security for availing a loan. Also nominaon facility is

available for this account.


10/2979

The POTD is oered for various duraons as menoned in the below table:

Duraon Interest rate (p.a.) *

One Year 6.25%

Two Year 6.50%

Three Year 7.25%

Five Year 7.50%

* These are current interest rates as of September 2010 and are subject

to change.

4.3 Marketable Fixed Income Instru-ments

The Government Securies and Corporate securies markets form two

main segments in Indian debt markets and play an important role in capital

formaon process. These securies form an important source of funds for

corporate and Government.

The market for government securies is the most dominant part of thedebt market in terms of outstanding securies, market capitalizaon, trad-

ing volume and number of parcipants. It sets benchmark for the rest of

the market. Major investors in Debt Market are shown in table on the next

page.

The Central Government mobilizes funds mainly by issue of dated securi-

es and T -bills. Dated Govt. securies are long term investment instru-

ments, where as T-bills are short term investment instruments. The major

investors in sovereign papers are banks, insurance companies and nancialinstuons, which generally do so to meet statutory requirements.


11/2980

Parcipants and Products in Debt Market

*Maturity as menoned in most cases. The same may be dierent in cer-

tain cases.

ISSUER INSTRUMENTS MATURITY* INVESTOR

CentralGovernment

CentralGovernment

StateGovernment

PSUs

Corporate

Corporate

Banks

Dated

Securies

T- Bills

State DevelopmentLoan

Bonds, StructuredObligaons

Debentures, Bonds

Commercial papers

Cercates ofDeposits

2 30 Years

91/364 Days

5 10 Years

5 10 Years

1 -12 years

15 Days to 1

year

3 months to1 year

RBI, Banks, InsuranceCompanies, ProvidentFunds, Mutual Funds,

Individuals, FIIs, trusts,Pension Funds

RBI, Banks, InsuranceCompanies ProvidentFunds, Mutual Funds,Individuals, FIIs, trusts,sociees, Pension Funds

Banks, Insurance com-

panies, Provident Funds,Individuals, insurancecompanies, mutual funds,trusts, sociees, PensionFunds

Banks, Companies,Provident Funds, Mutualfunds Individuals, Cor-porate, FIIs, insurancecompanies, trusts, socie-

es, Pension Funds

Banks, Mutual Funds,Corporate Individuals,FIIs, insurance compa-nies, Pension Funds

Banks, Mutual funds,Financial Instuons,Corporate, Individuals,

FIIs, insurance compa-nies, Pension Funds

Banks, Corporate, Indi-viduals, FIIs, insurancecompanies, mutual funds,Pension Funds


12/2981

4.4 Mutual Funds

Mutual Funds are an important nancial intermediary for an investor. They

are a vehicle to mobilise money from investors, to invest in dierent ave-

nues, in line with the investment objecves of the scheme. Professional ex-

perse along with diversicaon becomes available to an investor through

Mutual Fund route of investment. Through mutual funds one can invest

almost in all categories of assets.

Various advantages of Mutual Funds are:-

A) Porolio Diversicaon

B) Professional Management

C) Diversicaon of Risk

D) Liquidity

E) Convenience and FlexibilityF) Low Cost

The Structure of Mutual Funds

It is important for an advisor to understand the structure of mutual funds.

Their unique structure has various safety features built-in. The regulatory

oversight only adds to the safety of the investors money invested in the

mutual funds.

Mutual funds are constuted as public trusts in India. These are set up for

the benet of the unit holders, who are the owners of the fund. Unlike oth-

er investments, mutual fund is not an investment in itself but just a vehicle

to help an investor access various investment opons discussed earlier.

Investors pull their money and invest in a mutual fund

The money in the fund is managed by an enty called Asset Manage-

ment Company (AMC). The AMC invests the funds money in line withthe schemes objecves. The AMC is promoted by sponsors

Since the mutual fund is a trust, there are trustees who oversee the

management of the fund. Their job is to ensure the funds money is

managed in the best interest of the investors and as mandated by the

scheme objecves. Majority of trustees are independent of the spon-

sors of the AMC

The scheme earns returns through investment in various avenues

These returns are passed on to the investors in form of either distribu-

on of dividends or growth of capital. The AMC collects its professional fees for managing the funds money

SEBI, the securies market regulator, has issued detailed guidelines


13/2982

and regulaons for protecon of investor interests and regulated and

orderly growth of mutual fund industry.

Mutual funds can be open-endedor close-ended. Units of open ended

funds can be purchased from and sold to the fund houses on all working

days where as the close-ended funds do not allow the investors to redeem

units directly from the funds before maturity. Close-ended funds acceptpurchases only during the period of launch of the scheme, also known as

the NFO. These funds are not allowed to accept purchases aer the NFO is

over. Lisng of units of closed-end fund on one or more recognised stock

exchanges is mandatory to provide liquidity to exisng investors. The units

generally trade on the exchanges at discount to the NAV. Earlier, mutual

funds had an opon of oering liquidity through lisng on a stock exchange

or through a periodic redempon facility.

Each of the Mutual Funds has an objecve and terms of scheme statedin their Oer Document/ Key Informaon Memorandum, which every

investor must go through, in order to check if his own needs and objec-

ves match with the funds objecves. Mutual funds could invest in equity,

bonds, short term income instruments, Gold or other precious metals, or

Real Estate. Depending on these investments Funds could be classied as:-

a) Money Market or Cash or liquid Funds

b) Debt Funds

c) Equity Funds

d) Hybrid Funds

e) Exchange Traded Funds (ETFs)

f) Fund of Funds

Mutual funds could choose to invest in a mixture of above assets in any

combinaon or could invest in any parcular type of sector in that asset

and have accordingly been named in accordance with the investment

guidelines.

a) Money Market / Liquid Funds

These Mutual Funds invest the investors money in most liquid assets, like,

Treasury Bills, Cercates of deposit, Commercial papers etc. These instru-

ments in which Money Market Mutual Fund (MMMF) invests can be en-

cashed at a short noce; capital is safe though returns are low. Post tax the

returns from MMMF may be higher than keeping money in savings account

in the bank. These funds invest in debt instruments of short term nature

like Treasury Bills issued by Government, Cercate of Deposits issued by

Banks, and Commercial papers issued by companies. These are considered


14/2983

to be most liquid and least risky investment vehicles. Though interest rate

risk and credit risk are present, the impact is low as the investment vehi-

cles maturies are short and quality of papers is sound.

These are ideal for investors looking to park their short term surplus with

an objecve of high liquidity with high safety.

b) Debt or Income Funds

These funds invest in xed income generang debt instruments, issued by

government, private companies, banks, nancial instuons, and other

enes such as infrastructure companies/ulies. The main objecve of

these funds is to generate stable income at a low risk for the investor. As

compared to the Gilt funds these debt funds have a higher risk of default by

their borrowers. These funds can further be categorized as, a) DiversiedDebt funds, b) Short Term Debt funds, c) High Yield Debt funds, d) Fixed

Term Plans, e) Gilt Funds

Diversied Debt Funds

These funds invest in a diversied basket of debt securies. They can in-

vest in debentures issued by Government, companies, banks, public sec-

tor undertakings, etc. The objecve of these schemes could be to provide

safety of capital and regular income. At the same me, some funds mayalso have an objecve of generang higher returns than tradional debt

investments. This objecve can be achieved by proper management of cer-

tain risks, viz. credit risk, interest rate risk or liquidity risk.

Gilt Funds

These funds invest in government securies. Since the funds invest large-

ly in the securies issued by Government of India, the credit risk can beassumed to be non-existent. However, these government securies, also

called dated securies, may face interest rate risk, which means as the in-

terest rates rise, the NAV of these funds fall (and vice versa). The NAVs of

these funds could be highly volale, if the maturity is long. These funds are

also known as Government Securies Funds or G-Sec Funds.

Short Term Debt Funds

In order to reduce interest rate risk, some funds are mandated to invest indebt securies with short maturity, generally less than 3 years. Such funds

earn large part of returns in form of interest accrual and are less sensive


15/2984

to interest rate movements. These funds may or may not take liquidity and

credit risks. One would be advised to read the scheme objecves and in-

vestment style to know more about specic schemes.

These funds have the potenal to earn higher than liquid funds but the

NAVs of these funds also exhibit some degree of volality. At the same

me, the volality is likely to be much lower than diversied debt funds.

High Yield Debt Funds

High quality (those having high credit rang) debt securies oer low inter-

est rates and hence some investors are not happy with such low returns.

They are willing to take some risk without geng exposed to the risk of

equity.

High yield debt funds are ideally suited for such investors. These funds in-

vest in debt securies with lower credit rang. The lower rang ensures

the securies oer higher interest rates compensang the investor for the

extra risk taken.

Fixed Term Plans

As seen earlier, debt funds are subject to interest rate risk and the NAVs of

these funds uctuate if the interest rates change. Investors willing to holdthe investments for a dened term face the risk when they need to take the

money out of the scheme.

If there was an opon where the investors risk could be reduced as the

withdrawal me approaches, it serves a major purpose for the investor.

Fixed term plans, popularly known as FMPs (Fixed maturity plans), have a

dened maturity period; say 3 months, 6 months, 1 year, 3 years, etc. The

maturity of the debt securies in which the fund invests, and the maturity

of the scheme are almost the same. Hence, when the scheme matures andmoney has to be returned to the investors, the fund does not have to sell

the bonds in the market, but the bonds themselves mature and the fund

gets maturity proceeds. Since the fund does not have to sell the bonds in

the market, the fund is not exposed to interest rate risk.

These are close-ended debt funds. The units of these funds have to be list-

ed on a stock exchange to provide liquidity to the investors.

These funds are ideally suitable for investors who know the me when they

will need the money and also do not need money before the maturity of

the FMP.


16/2985

c) Equity Funds

These funds invest in equies and depending on the type of equies these

funds have been further classied as, a) Growth funds, b) Value funds, c)

Dividend Yield funds, d) Large Cap funds, e) Mid Cap or Small Cap funds, f)

Speciality funds or Sector funds, g) Diversied Equity funds and h) Equity

Index funds. Certain equity funds have tax benet under secon 80C of theIncome-tax Act, 1961 and have a lock in period of three years. These are

Equity Linked Savings Schemes popularly called as ELSS. These funds have

higher risk, but potenal for higher returns.

Growth funds

These funds invest in the growth stocks, which ie stocks that exhibit and

promise above average earnings growth. Managers using the growth styleselect stocks which are normally quite high prole. Such stocks being high

growth are more visible and also have high investor interest. Due to this,

the stocks may appear to be costly on historical valuaon parameters.

However, the high valuaon is jused by the expected high future growth.

Value funds

As the name suggests, value funds buy value stocks as we discussed earlier.

Such stocks are generally out of favour with most investors in the marketand hence the market price is low as compared to the inherent value of

the business. The value style managers generally hold the stocks for longer

me horizon than their growth style counter parts.

Dividend yield funds

One of the valuaon parameters a value style fund manager looks for is

high dividend yield. However, there is a category of funds that consider thisone parameter as the most important factor to select stocks. As compared

to other parameters of considering value, dividend is believed to be more

reliable as it involves cash movement from the company account to the

share holder account and hence there is no room for any subjecvity.

Large cap funds / Mid cap funds / Small cap funds

Equity mutual funds can be classied based on the size of companies in-

vested in. In capital market terms, the size of the companies is measured in

terms of its market capitalisaon, which is the product of number of out-

standing shares and the market price. It also denotes the price the market


17/2986

is willing to pay to buy the enre company. Larger the market capitalisaon,

larger the company. In popular usage, the word market capitalisaon is re-

ferred to as cap.

Fund invesng in stocks of large companies are called Large Cap Funds and

those invesng in stocks of midsized companies are called Small Cap Funds.

Speciality / sector funds

Certain funds invest in a narrow segment of the overall market. The belief

here is that stocks in similar industry move together, as companies in such

sectors are similarly impacted due to some factors. There are funds that

invest in stocks of only one industry, e.g. Pharma Funds, FMCG Funds or

broader sectors, e.g. Services Sector Fund or Infrastructure Fund. Similarly,

there could be themac or speciality funds that invest based on some com-

mon theme, e.g. PSU Funds or MNC Funds.

Most advisors recommend that an investor would be beer o keeping the

exposure to such funds limited. These funds are more suitable for aggres-

sive and savvy investors.

Diversied equity funds

These funds invest in stocks from across the market irrespecve of size, sec-tor or style. The fund manager has a greater freedom to pick up stocks from

a wider selecon. Most advisors advise investors to have diversied funds

as core part of their porolio. These funds, being diversied in nature, are

considered to be less risky than themac or sector funds.

Index funds

In all the above categories of funds, the fund manager plays an acve role

in carefully selecng stocks to build the porolio.

d) Hybrid Funds

These are mixed equity and debt funds. Depending on the objecve these

funds can be further classied as a) Balanced funds, b) Monthly Income

Plans (MIP) and c) Asset allocaon funds.


18/2987

Balanced funds

The most popular among the hybrid category, these funds were supposed

to be invesng equally between equity and xed income securies. Howev-

er, in order to benet from the provisions of the prevailing tax laws, these

funds invest more than 65% of their assets into equity and remaining in

xed income securies.

These funds are preferred by investors who seek the growth through in-

vestment in equity but are not very comfortable with the volality associ-

ated with pure equity funds.

Monthly Income Plans (MIPs)

This category of funds invests predominantly in xed income securies

with marginal exposure to equity. The xed income component provides

stability to the porolio, whereas equity provides capital appreciaon over

long periods of me. Generally, 80% of the scheme corpus is invested in

xed income securies and the balance 20% in equity. However, the al-

locaon could be dierent from the above. Recently, some fund houses

have also launched schemes under this category that invest in equity, xed

income and gold.

These funds are ideally suitable for any investor who wishes to have steadygrowth of capital with the ability to beat inaon over long periods of me.

Asset allocaon funds

We saw earlier that asset allocaon is a very important part of the invest-

ment plan. Advisors have a choice of either construcng porolios for

their clients through careful selecon of components. Alternately, they can

also look at readymade soluons available in the form of Asset Allocaon

Funds launched by certain mutual fund companies. These funds are de-

signed with certain investor proles in mind and most of the fund houses

also oer tools to match the investor prole with the various opons under

these funds.

e) Exchange Traded Funds (ETFs)

These funds combine the best features of open and closed mutual fund

schemes, and trade like a single stock on stock exchange. Thus these fundscan be purchased and sold at real me price rather than at NAV, which

would be calculated at the end of the day. These funds, available in India


19/2988

track indices (e.g. Niy, Junior Niy or Sensex) or commodies like Gold

(Gold ETFs). Recently, acve ETFs have also been introduced in Indian mar-

ket. ETFs are very popular in other countries, especially USA. The biggest

advantage oered by these funds is that they oer diversicaon at costs

lower than other mutual fund schemes and trade at real me prices.

f) Fund of Funds (FOF)

Mutual funds that do not invest in nancial or physical assets, but invest in

other mutual fund schemes, are known as Fund of Funds. Fund of Funds

maintain a porolio comprising of units of other mutual fund schemes, just

like convenonal mutual funds maintain a porolio comprising of equity/

debt/money market instruments or non nancial assets. There are dier-

ent types of fund of funds, each invesng in a dierent type of collecve

investment scheme. Fund of Funds provide investors with an added advan-tage of diversifying into dierent mutual fund schemes with even a small

amount of investment, which further helps in diversicaon of risks.

4.5 Equies

In simple terms, invesng in equity means either invesng ones funds in a

business that isrun by self or becoming a shareholder in other businesses,

thus taking a higher risk, but with a higher potenal of returns. If company/business does well and makes prot, the investor is going to benet as he

is part owner of this prot, however if the business goes in loss, the inves-

tor would also lose proporonately. Thus it is important to understand the

fundamentals of the company/business in which one is invesng. If an in-

dividual does not have the experse to analyse the business and company,

he could use the experse of others in the eld by either invesng through

mutual funds or Porolio Managers.

Investments in equies have a higher potenal for returns, though withhigher risks too, as one must understand risk and reward go hand in hand.

Knowledge, experse in analyzing the equies and longer horizon of invest-

ment, would help to considerably reduce the risk.

Returns from equies could be in the form of capital growth, dividends or

both. In order to know the growth potenal of a company/business, it is

prudent to analyse the balance sheet, prot and loss statement and cash

ow statement of the company and compare it with previous years state-

ments and peer companys statements.


20/2989

Few of the important terms are described below to help understand these

aspects:

a) Earnings per share (EPS):- This is net prot minus dividend earned by

preference shares, divided by number of equity shares.

b) Dividend percentage: - This is dividend per share divided by face valueof share and then mulplied by hundred to get the percentage.

c) Dividend yield (%):- This rao gives the return in terms of dividend

you receive by buying a share in market. It is the dividend per share

divided by market price of the share, and then mulplying by 100 to

get the percentage.

d) Price-Earnings Rao (P/E Rao):- It is market price of share divided by

earning per share. In other words it indicates the number of mes theearning per share, the market is valuing the share.

e) Book Value: - This is dened as (Equity capital + net shareholders

reserve)/ no. of equity shares. Whenever the book value of a company

is higher than the market price of the company, it indicates the share

of the company is available at a discount.

Analysis of nancial statements is necessary but not sucient. One must

analyse the business dynamics as well e.g. market size, customer prefer-

ences, compeon, regulaons etc.

Investors in equity shares employ certain parameters for the selecon of

stocks in their porolios. Two popular styles used are growth and value.

Under value style, the investors select stocks which are priced very low

compared to their inherent value. In order to determine this, the investors

look at parameters like low price-to-earnings rao, low price-to-book value

rao, high dividend yield, etc. Generally, such stocks are out of favour withmost investors and hence the value style managers are somemes referred

to as contrarian investors. On the other hand, there are stocks that exhibit

very high rate of earnings and business growth. Such stocks are known as

growth stocks and are favourite picks for growth style investors. Generally,

growth stocks exhibit high price-to-earnings rao, high price-to-book value

rao and low dividend yields.

Various ways of invesng in equies for an individual are:-

1. Equity Oriented Mutual Funds2. Porolio Management Schemes

3. Direct Investment in Equies.


21/2990

4.6 Derivaves

These are basically risk management leveraged instruments, which derive

their value form the underlying assets. These are extensively used by Hedg-

ers, Speculators, and Arbitragers. Speculaons in derivave markets can be

very risky, where as if used with proper knowledge as risk management in-

struments; these could help to protect the returns of the underlying asset.

Various derivaves in use are:

i) Forwards

ii) Futures

iii) Calls

iv) Puts

v) Swapsvi) Warrants

vii) Leaps

Index futures were started in the year 2000 in India and later on stock fu-

tures and index and stock opons were added to the F&O segment at ex-

changes in India. CALLS and PUTS are types of opons, which give the buyer

a right to buy or sell the underlying asset, without any obligaon to do so.

In order to get this right the buyer of an opon pays an amount, called the

premium, to the seller (also called writer) of the opon. Thus the seller ofthe opon has an obligaon whereas the buyer has the right to buy or sell.

This results in a possibility of limited loss or unlimited gain for the buyer of

the opon and the reverse for the seller of the opon.

Buying or selling futures contracts is similar to going long or short on stocks,

except that one pays only margin money while going long or short on fu-

tures where as in case of stocks full payment is made. There is a possibility

of unlimited loss or unlimited gain when the security moves against or in

the expected direcon of the investor.

Futures could be used for Hedging, Arbitrage, and Speculaons.

Hedging is basically protecng your assets from losses; however it does

not maximize the prots. If one is holding a stock already in prot and feels

the stock might fall in near future temporarily, one can protect the prots

by selling a future in F&O segment. This would compensate him from any

losses in cash market from fall of the stock price. A hedge does not result in

beer outcome; it results in more predictable outcome.


22/2991

In an Arbitrage opportunity one can take advantage of dierence in prices

in dierent markets, and thus look for risk free gains. Say stock price in cash

market is signicantly lower than the futures price. One buys the stock in

cash market and sells the same stock in futures markets, and thus ensures

prots, as at the end of expiry of futures (the last Thursday of the month)

price of stock in cash and futures markets would be the same. Stock mar-

kets could move in any direcons but your prot, which is generally low, isbooked.

Speculators oen take posions in futures markets based on their expecta-

ons regarding the price movements of the underlying assets without hav-

ing a posion in cash markets.

Commonly used terminology in Opons market is:

a) Call Opon: This opon gives the buyer a right to buy the underlyingat a predetermined price during a predetermined period. Call opon

gives the buyer a right to purchase the shares/underlying asset at a

price which is below the market price and vice versa for seller.

b) Put Opon: This opon gives the buyer a right to sell the underlying

at a predetermined price during a predetermined period. Put opon

gives the buyer the right to sell the shares/ underlying asset at a price

which is above the market price.

c) American Opon: This opon can be exercised at any me on or be-

fore the expiry day/date.

d) European Opon: This opon can be exercised only on its expiry.

e) Strike Price/ Exercise Price: Its the price at which an opon is exer-

cised.

f) Expiry Day/Date: The day/date on which opon expires and the con-

tract ceases to exist.

g) Exercise Day/Date: The day/date on which opon is exercised.

h) In The Money Opon (ITM): If the strike price is more than the market

price of the underlying it is said to be in the money (ITM) opon. Thus

a CALL opon would be in the money when market price of the under-

lying asset is more than the strike price and for the PUT opon to bein the money, the market price of the underlying asset is less than the

strike price.


23/2992

i) Out Of The Money Opon (OTM): If the strike price is less than the

market price of the underlying asset, it is said to be out of the money

(OTM). Thus a CALL opon would be out of the money when market

price of the underlying asset is less than the strike price and for the

PUT opon to be in the money, the market price of the underlying as-

set is more than the strike price.

j) At The Money Opon (ATM): When the strike price and the market

price of the underlying are equal the opon is called at the money

(ATM).

k) OPTION PREMIUM: It is the price which an opon buyer pays to the

seller to buy this opon/right. The opon premium is the inow for

the opon writer/seller, whether the buyer exercises the opon or

not. The opon premium consists of two components Intrinsic value

and me value. The intrinsic value of an opon is the amount by whichopon is in the money. Thus only, in the money opons have intrinsic

value and all out of the money and at the money opons have zero

intrinsic value. In these cases opons have only me value in its pre-

mium. The me value of the opon is also called the extrinsic value of

the opon.

With respect to European opons, we have the following four major strate-

gies:

Buy a Call opon:

This gives the buyer of the opon the right to buy a security on a specied

date in future at the specied price, also known as strike price. The buyer

of opon pays a premium to the seller of opon (also known as writer). The

buyer exercises the right if on the specied date, the strike price is lower

than the market price (spot price) of the security.

Buy a Put opon:This gives the buyer of the opon the right to sell a security on a specied

date in future at the specied price (strike price). The buyer of opon pays

a premium to the seller of opon. The buyer exercises the right if on the

specied date, the strike price is higher than the market price (spot price)

of the security.

Sell a Call opon:

This obligates the seller (writer) of the opon to sell a security on a specieddate in future at the specied price (strike price), if the buyer of the opon

exercises the right to transact. The seller of opon receives a premium from


24/2993

the buyer of opon. The buyer exercises the right if on the specied date,

the strike price is lower than the market price (spot price) of the security.

Sell a Put opon:

This obligates the seller (writer) of the opon to buy a security on a speci-

ed date in future at the specied price (strike price), if the buyer of the op-

on exercises the right to transact. The seller of opon receives a premiumfrom the buyer of opon. The buyer exercises the right if on the specied

date, the strike price is higher than the market price (spot price) of the

security.

Non Financial Assets

Commodies

So far we have discussed about the nancial investment instruments, which

are all in paper form, whereas the commodies are the real assets like, ag-

ricultural products, metals, bullion, silver, oil etc. Derivave contracts on

these products are traded on commodies exchanges like, MCX and NCDEX

in India. Investment in commodies could be done through mutual funds

(only for gold), derivaves or directly. Investment in gold is good for hedg-

ing against inaon. The best way to invest in gold is using gold exchange

traded funds. This route of investment in gold decreases the cost and taxa-

on, and gives safety against the. The liquidity and divisibility is good.

4.7 Real Estate

In India most of us have our major investment in acquiring a house. Every

one dreams of having a house of ones own.. There is plenty of scope for

the planners to professionalize in this eld. A house where one lives is a

personal asset. It is the second house or other forms of real estate which

could form the investment vehicle, as these would be the ones giving re-turns. We could categorize the real estate in following types:

a) Residenal Property.

b) Commercial property.

c) Industrial real estate

d) Agricultural land.

e) Semi urban land.

f) Time share in a holiday resort.

Residenal Property: This investment vehicle provides returns in the form

of rent and capital appreciaon. Tax rebates are available on interest paid


25/2994

and principal repayment when the investment is through a loan. Further,

long term loans at aracve rates make this investment aracve.

Commercial property: For an investor, construcng a commercial complex

or buying a shop or oce in a commercial complex could oer regular rent-

al income and capital appreciaon over a me period. However this invest-

ment requires sucient outlay and me and eort in managing it.

Agricultural land: Agricultural income from agricultural land is not taxable.

Further, agricultural land is exempt from wealth tax too. Appreciaon in

agricultural land value along with regular income makes it an aracve in-

vestment vehicle.

Semi urban Land: Residenal land in suburban areas is usually available

at prices lower than those prevailing in the city. This is usually a converted

land in private layouts and has a high potenal for capital appreciaon asthe infrastructure increases and surrounding areas develop.

Time Share in a Holiday Resort: The concept of me share holidays is in-

creasing every day. The outlay is modest and aordable. It could prove

especially useful for people who like to enjoy regular vacaons. The stay

period if not used could be rented and value of me share also increases

over a me period. The investment can be passed in a will and can also be

sold in future.

Real estate investments require a large investment, and thus needs to be

nanced. For house, loans could be taken from various nancial instuons

or from employer. Loans for houses are available usually at a concessional

rate as compared to other loans.

Other Investments:

Art objects, collecbles and precious stones are costly and illiquid invest-ments. These require lot of knowledge in these products and one really

has to know the market for these products to be able to buy and sell these

products. One should be cauous while making such investments.

Private Equity: It is the money invested in rms which have not gone pub-

lic and therefore they are not listed on any stock exchange. Private equity

is highly illiquid because sellers of private stocks must rst locate prospec-

ve buyers. Investors in private equity are generally compensated when:

(i) the rm goes public (ii) it is sold or merges with another rm or (iii) it isrecapitalised.


26/2995

Venture capital: Venture capital is a type of private equity investment. In-

vesng in new projects or entrepreneurial business, in exchange for an eq-

uity stake in the business involves high risks. As a share holder, the return

is dependent on the growth and protability of the business. This growth

is generally earned by selling its shareholding when the business is sold to

another owner.

Before recommending any investment vehicles, it is preferable to consider

your clients nancial needs, goals, and aspiraons, as well as the risk pro-

le.

SUMMARY:

Investment is commitment of the capital to purchase assets in order to

protably gain in the form of regular income or appreciaon of assets.These assets could be nancial or real/non nancial assets. Inaon, Tax

and risk of losing capital are the main concerns while invesng. Risk and

reward go hand in hand, higher the risk more is the reward expected. Fi-

nancial investment vehicles could be cash instruments, Debt instruments,

or equity, cash instruments being least risky while equity being most risky.

Real or non nancial instruments could be commodies, bullion, real es-

tate, collecbles and art. Investment in gold is a good hedge against ina-

on. While choosing to invest in any asset, one must align it to ones nan-

cial goals and the risk prole.

In India, the concept of saving is well understood by majority, however

very few understand the concept of invesng.

Invesng is comming capital to purchase assets in order to protably

gain in the form of regular income or appreciaon of capital or both.

Before recommending any investment vehicles, it is preferable to

consider your clients nancial needs, goals, and aspiraons, as well as

the risk prole. Important concerns while invesng capital are Inaon, Tax, and risk

to capital, Returns, liquidity and divisibility.

Investment vehicles could be broadly classied into nancial assets

and real/non nancial assets; nancial assets are further subdivided

into, cash, debt, equity and derivave instruments. Commodies, real

estate, bullion, collecbles, art etc. form the non nancial assets.

Mutual funds form an important investment vehicle, as it is possible to

invest in most of the assets through mutual funds.

It is important to keep three to six months expenses in cash instru-ments for looking aer any unforeseen emergencies.

Short term requirements should preferably be kept in debt instru-


27/2996

ments. Provident fund / PPF is good investment, being safest and tax

friendly, however being illiquid. For senior cizens, senior cizens sav-

ing scheme is a good investment to get regular income for 8 years.

Equies though are riskier investments; they provide higher returns.

For long term investors, equies are good investments to beat ina-

on.

Derivaves are leveraged risk management tools, however could provevery risky if used for speculaon. One requires a thorough knowledge

of derivaves in order to use them protably.

Real estate requires large outlay of capital. This should form long term

investment where liquidity is not an immediate requirement.

Gold is a good hedge against inaon. Investment in Gold through

ETFs can prove very easy and protable, due to less cost of procure-

ment, safety and tax benets.


28/2997

* In PPF scheme, the maximum invest periods can be 16 years.

Sr. No.

1.

2.

3.

4.

5.

6.

7.

8.

Name of

Scheme

Savings Bank

Post Oce Re-

curring Deposit

Post OceTime Deposits

MonthlyIncome Scheme

Kisan VikasPatra

6 Years NaonalSavings Cer-cate VIIIth issue

Sr. CizenScheme 2004

Public Provi-dent FundScheme

Period

-

Five years (can

be extended upto ve years)

One Year

Two Years

Three Years

Five Years

Six Years

Eight Years andseven months

Six Years

Five years

Fieen years

Maturity Value

-

For Rs.100

denominaonRs.728/-

Interest paidyearly

-do-

-do-

-do-

Interest paidmonthly plus5 % bonus onmaturity

Double aermaturity

For Rs.1000/-Rs.1601/-

Interest paidquarterly

For depositRs.500/-permonth getsRs.1,85,156/considering aperiod of 15years* of actual

investment

Rate of

Interest

(p.a.)

3.50 %

7.50 %

6.25 %

6.50 %

7.25 %

7.50 %

8 %

8 %

8 %

9 %

8 %


29/29

Review QuesonsQuesons to assess your learning:

1. Which of the following account cannot be opened under PPF scheme?

a) Account in the name of Mr. X who is a resident

b) Account on behalf of Mr. Y who is resident minor

c) Account in the name of Mr. and Mrs. X (both are resident)

d) Account in the name of Mr. Z who is resident

2. For how many years an account under senior cizen scheme can be

extended?

a) 5 years

b) 3 yearsc) 1 year

d) 6 years

3. The Price at which opon is exercised is known as ___________.

a) Market Price

b) Book Price

c) Strike Priced) All of the above

4. If a PPF account is opened in FY 2005-2006, the same will normally

mature on ____________.

a) 31st March, 2021

b) 1st April, 2020

c) 1st April, 2021

d) 31st March, 2020

5. What is the range of period for which Treasury Bills (T-Bills) are is-

sued?

a) 91days to 364 days

b) 90 days to 180 days

c) 1 year to 3 years

d) 2 years to 25 years

Investment Vehicle

Documents

Transcript of Investment Vehicle